The Peace Dividend: It Belongs to the People Not Congress

752 February9,1990 THE PEACEDMD IT BmNGS TO THE PEOPLE, NOT
CONGRESS INTRODUCTION As soon as the first holes were punched
through the Berlin Wall, and Eastern Europe began its breathtaking
rush toward democracy, there was talk in Washington of a Peace
Dividend and of ways to spend it. With the Cold War now ending, the
argument goes, major cuts can be made in th e United States defense
budget, freeing billions of dollars to tackle Americas domestic
problems. Indeed, many organizations and lawmakers have held press
conferences to outline their views of how this windfall should be
spent programs, however, raises two issues that advocates of new
spending seem determined to ignore household actually banks the
returns on its investments before it spends the money. So far there
is no big dividend and there will not be any so long as
Eastern-Europe-and-the-Soviet Union-re main in turmoil-and so long
as there is no consensus in the U.S. regarding Americas future
defense needs. Yet the Peace Dividend lobby blithely urges Congress
to commit the federal govern ment to huge new programs.

Escaping Spending Limits. The spending lo bbies, of course, have
a strong incentive to declare the dividend to be real and
available, and to press for funds to be committed as soon as
possible.This would allow escape from the straitjacket of the
Gramm-Rudman-Hollings budget ceiling which has held back the
natural appetite of lawmakers to spend. And by committing funds
now, and creating the agencies and their satellite interest groups,
programs The popular notion of a Peace Dividend available for new
federal The first is whether there really will b e such a dividend.
A prudent can be established which will prove politically
impregnable should the Peace Dividend turn out to be a financial
mirage mirage. For one thing, the euphoria of late 1989 in Eastern
Europe is begin ning to give way to the stark r e ality that
democracy is a fragile thing. An un stable Eastern Europe, with the
Soviet Union on its doorstep, poses many potential security threats
to the West. For another thing, increasing signs of instability
within the Soviet Union itself- atnuclear su perpower are deeply
worrying. It is hardly time to dismantle Western defenses.

The second issue concerns the way any real Pentagon savings
should be treated. The Peace Dividend lobby assumes that the only
way to solve any problem is to create a new federal program and
spend money. As Senator Phil Gramm, the Republican fromTexas,
observes, as the Vietnam War was winding down, the defense budget
was cut by $74 billion between 1970 and 19

77. The government spent every penny saved and increased the
budget def icit. Yet many of the countrys problems, from young
families finding it hard to pay for day care to older workers
worried about potential nursing home bills, could be solved by tax
law changes that put money back in the pockets of Americans.
Several tax r elief strategies, moreover, are partially
self-financing, since they generate new employment and thus new
taxpayers and new revenue.

If a Peace Dividend materializes, Congress should consider a
number of tax relief strategies. Among them 4 4 Roll back the
Social Security payroll tax. This tax strangles job crea tion and
boosts unemployment and welfare dependency among the unskilled.

Rolling back the tax to lower rates would reduce welfare and
unemployment costs and provide new employment opportunities for
Americans 4 4 Provide tax relief for the purchase of nursing home
insurance. Many Americans wony about crippling long-term nursing
home costs. Som e law makers want an expensive new federal program
to fund such care. A much sounder policy would be to foster the use
of long-term care insurance through tax incentives Signs of
Instability. There are good reasons to fear that it may be a 4 4
Increase the personal exemption. The financial pressures on young
families with children have prompted calls for federal day care
centers and other programs. But the financial pressures stem in
large part from the grow ing burden of federal taxation. Increasing
the fe d eral tax codes personal ex emption would return money to
these families, reducing or eliminating the need for direct
services 4 4 Expand the Earned IncomeTax Credit (EITC The liberal
estab lishment.continually argues for more welfare programs,
despite mou n ting evidence that these do very little to reduce
long-term poverty and do very much to increase dependency. An
alternative would be to give a strong incen tive for the poor to
join the workforce by expanding the EITC, a wage subsidy 2 to
low-income worke r s. This would use federal assistance to make
work far more attractive to those currently on welfare dress social
problems.This is much better than creating new programs to spend
taxpayers dollars in ineffective ways.The Peace Dividend debate of
fers Congr e ss and the White House the chance to prove that the
only way to s.o!ve..any.problei. is nor .to- t and spend. The
debate.$g$d highlight the benefits of tax relief strategies These
and similar measures return tax dollars to Americans in ways that
ad I A ME N U FOR TAX RELIEF For each major new spending program
now being offered to deal with American problems, there are tax
relief strategies that would be more effec tive. In aggregate,
these strategies would cut taxes more than a Peace Dividend would
save. Thu s the strategies constitute a menu from which law makers
can select. Several of the proposals, such as cutting the capital
gains tax, would yield new revenues or spending reductions that
would cover all or much of their cost. In other cases, such as an
exp a nded Earned IncomeTax Credit, they would trim costs of
existing programs. Even without a Peace Dividend, therefore, many
of these proposals would improve policies while reducing the
deficit lap. Example: The toddler tax credit and the ElTC reform
assist s i milar populations of low-income families. If the toddler
tax credit were enacted the ElTC expansion could be scaled back
without a loss of income to low-in come parents.Thus the cumulative
revenue cost of all the proposals, if enacted together, would be w
e ll below the cumulative total of the estimates for each program
Although treated independently, some of these tax relief proposals
do over Among the most important tax-relief strategies lawmakers
should consider 1) Roll Back Social Security Payroll Taxes and
Return Social Security to Pay-As-You-Go Financing Revenue Reduction
55 billion per year after 1990.

Offsetting New Revenues 15 billion in income tax and payroll
taxes from new jobs.

Ever since the Social Security system was created in 1935, the
burden of federal payroll taxes on middle-income families has risen
continuously. In 1937, the payroll tax was set at two percent of
payroll income under $3,000 by 1980 it was 12.3 percent; and this
year it climbed to 15.3 percent of income 1 2 Estimated reduct ion
in revenues from the specific tax Estimated new revenues from other
taxes, or reduction in outlays, from the policy change 3 under
$51,3

00. Half of these taxes are paid directly by the worker and half
paid indirectly by the worker as payments by the employer. Counting
the employers contribution, in 1990 an American worker will pay up
to $7,800 in payroll taxes.

As a result of seven payroll tax hikes in the 198Os, the vast
majority of American workers now pay a larger share of their total
income in fed eral me! America, creeping Social Security tax
increases have eroded all of the income tax relief provided by
Congress and Ronald Reagan in 19

81. Moreover, 80 percent of American families now pay more in
federal payroll taxes than in federal income taxes.

Worthless IOUs. Todays high payroll tax rates are not necessary
to keep the Social Security program in the black for at least the
next three decades.

Nor are they being used to build up a Social Security trust fund
reserve to pay benefits in the next century when the baby boom
generation retires.

Rather, Congress continues to raid the Social Security trust
fund to pay for other programs.There is no money in the trust fund;
all that is there is a stack of government IOUs. When the baby
boomers retire in the next century and demand payment of their
retirement benefits, the Social Security trust fund will be holding
as much as $12 trillion of worthless IOUs. To redeem them,
theTreasury will have to raise taxes, borrow, or print money.

Social Security taxe s should be enough only to finance current
outlays a pay-as-you go system.This would allow the payroll tax to
be trimmed by about 2.2 percentage points, giving Americans a $62
billion tax cut over the next two years and even more in future
years. Senator D aniel Patrick Moynihan, the NewYork Democrat and
Chairman of the Senate Finance Subcommittee on Social Security, has
proposed such a plan. He correctly em phasizes that such a tax cut
would not affect Social Security benefits; it simply would end the
fict ion that contributions are being put aside to pay for future
benefits.

Fueling Growth. More important, a payroll tax cut would fuel
productivity growth, job creation, and higher American living
standards. The payroll tax has proved to be one of the most ec
onomically destructive ways for the government to raise revenues
because it deters businesses from hiring new workers and expanding
output. Former U.S. Treasury economists Aldona and Gary Robbins
estimate that the 1988 and 1990 payroll tax hik-es rob the American
economy of 510,OOO jobs and reduce the nations GNP by $320 bil lion
over ten years. By contrast, they argue, every dollar reduction in
Social Security taxes would expand economic output by 68 cents.

Some critics, however, complain that todays high Social Security
taxes are needed to keep the retirement program solvent in the next
century. But a decade of experience convincingly demonstrates that
Congress is unable to avoid the temptation to spend excess Social
Security funds. With or without a tax cut, no reserve funds will be
accumulated. The best way to ensure the ability of the Social
Security system to pay future benefits is through pro growth tax
policies today, so that future workers are able to finance future
they. did in 19

80. This means t hat for most of-eddle-income 4benefits without
heavy taxes. For instance, if real per capita income in the U.S.
rises 2 percent per year between now and the year 2030, about the
rate during the 198Os, real incomes will be twice what they are
today. Cuttin g payroll taxes will make such growth more likely.
Allowing recent payroll tax hikes to remain in place will slow down
growth flate. the. budget defidt aljo are_ mistaken: Regre$sjye
Security taxes were neverintended to finance the budget deficit or
any go v ernment pro gram other than Social Security. Moreover, a
payroll tax cut would not preclude a balanced budget by 1994.The
deficit can be eliminated, without new taxes, by freezing all
nonSocia1 Security spending for the next four years. Alternatively,
if a ll non-Social Security spending is held to 2 percent growth
for four years, the budget deficit will fall to below 2 percent of
gross national product in 1994.This would be one-third the level of
annual debt ten years earlier and below the deficit rate for most
industrialized countries.

Neither of these projections, moreover, assumes the stimulative
economic ef fect of the payroll tax cut. Yet a tax cut would spur
faster job creation, thereby increasing income tax revenues and
redu cing welfare outlays, thus helping to reduce the deficit Those
who argue that the payroll tax should not be cut because this will
in 2) Reduce the lax Burden on the Elderly by Eliminating the
Social Security Earnings lest Revenue Reduction 5 billion per y ear
Offsetting New Revenues 2.6 billion per year in taxes from extra
work per formed by the elderly.

Federal tax policies are keeping out of the labor pool a group
of workers that is growing in number and possesses needed skills
Americans over age 65.The f ederal government now slaps the working
elderly with so many tax penalties that hundreds of thousands
literally find it too expensive to work.

The most onerous of these tax penalties is taxation of Social
Security benefits and the earnings test, which red uces Social
Security benefits for working senior citizens. These taxes and
benefit reductions impose marginal tax rates of 50 percent to 70
percent on many elderly workers. Americans who con tinue to work
after age 65, and do not apply for any Social Secu r ity benefits
do receive a 3 pereiit incTease in-their monthly Social Security
benefits when they eventually retire.This is known as the Delayed
Retirement Credit. Yet the credit is insufficient to restore
lifetime Social Security benefits to those who con tinue to work
after the age of 65.

Today more than 80 percent of all men and 90 percent of all
women over age 65 are fully retired, many because they no longer
find it worthwhile to work. The federal tax code should not
discourage older Americans from work ing and contributing to
economic growth.To end this disincentive, the Social Security
earnings test for workers between ages 65 and 69 should be
eliminated (there is no penalty on those older than 70).The
earnings test re 5 q 1 1 d S a a il S P ii s u 0 1 1 F u b C Cl 0 t
S E H 3 n P fc ii a h g 0 ti res workers in this age group with
earnings over $9,360 to forfeit one dol u of Social Security
benefits for every three dollars earned from working his is an
effective 33 percent tax on earnings, on top of al l the other
federal tate, and local taxes that are deducted.The main effect of
this heavy tax is to hive many low- and middle-income senior
citizens out of the labor force lome 500,000 moderate income
seniors with incomes below $40,000 per year re penalize d by the
earnings test. The average Social Security benefit is now
bout-.$6O

per-month,~nd.many-retirees who depend ody-on Social Security
ncome live at or near the poverty level. Many must work to
supplement their locial Security payments to make ends mee t. But
today, elderly Americans rith earnings as little as $5.00 an hour
can be hit by the earnings test work lenalty.

Freedom to Work Senator William Armstrong, the Colorado
Republican ntroduced legislation last session that would raise the
income thresh old level a the earnings test gradually so that it
affects fewer moderate income elder This would be a desirable
reform. Better would be the Older Americans reedom to Work Act,
sponsored last year by Representative Dennis Iastert, the Illinois
Republican. This bill, with more than 100 cosponsors rould repeal
the earnings test entirely.

Some in Congress claim that eliminating the earnings test would
increase lenefit payments substantially and thus add to the federal
budget deficit.The longressional Budget Of fice has estimated that
earnings test repeal would ost Up to $5 billion annually. But these
estimates ignore the work incentive f eliminating the tax. Extra
work by the elderly means more regular income ax revenue.The
additional taxes paid by the elderly w ho increase their hours
rorked would recapture about one-half of these costs, according to
a study by ltephen Entin of the Washington-based Institute for
Research on the konomics of Taxation 1) Index Social Security
Benefits for Inflation Revenue Reductio n 430 million per year
Offsetting New Revenues: Negligible.

One of Ronald Reagans primary economic policies was to stop
govern lent fromnsing inflation to capture an increasing share of
each Americans aycheck through the tax code. Reagan successfully
urged Congress to index Zderal tax rates, so that inflationary
rises in income would not push taxpayers it0 ever higher tax
brackets. Indexing taxes for inflation now extends to most spects
of the tax code.

Penalizing Senior Citizens. Yet for the elderly, the group
generally most armed by inflations erosion of savings, the tax code
still explicitly penalizes aim due exclusively to rising prices.
The reason: All Social Security benefits ollected by elderly
Americans with gross income over $25,000 are treated as aable
income at a rate of 50 cents for every additional dollar earned.
This 6pushes an elderly worker in, say, the 28 percent tax bracket
into an effective 42 percent bracket, and thus destroys work
incentives.The income tax threshold level of $25,OOO 32, 0 00 for
working couples moreover, is not in dexed to inflation, unlike the
rest of the personal income tax code. Hence when incomes are raised
to keep up with inflation, a larger number of middle income elderly
are subject to the tax, even though their rea l incomes have not
risen. Failure to index the tax on Social Security benefits to
inflation is Congresss- back-door way of raising taxeson senior:
citizens.

Even if congressional supporters of repealing the Social
Security earnings test are successful, the beneficial impact of
this reform would be reduced be cause of the tax treatment of
benefits. Some 300,000 working elderly already are subject to both
the earnings test and the Social Security benefits tax.To end this
unfair tax penalty on the elderly, Co n gress should index the
income threshold level of the benefits tax so that inflation does
not reduce real in comes of elderly working Americans 4) Increase
the Personal Exemption to $6,300 for Each Child Under Age 18 per
child under age 18 would cut income tax revenues by about $40
billion a year Revenue Reduction: Raising the personal exemption
from $2,000 to $6,300 Offsetting New Revenues: None The federal
income tax burden on American families with children has soared by
over 2,500 percent since 1948 fro m 0.3 percent of income to 8 per
cent. Four decades ago, a family of four at median family income
paid virtual ly no income taxes, and only $60 a year in Social
Security taxes (2 percent of income). This year, the equivalent
family will pay $2,787 in incom e taxes and over $5,OOO (15.3
percent of income) in employee and employer shares of the Social
Security tax. Single individuals and married couples without
children have not had their taxes increased to the same extent and
today pay about the same portion of their income in income taxes as
they did in the 1950s.

The main reason that young families now pay a disproportionate
share of taxes is the erosion of the value of the personal
exemption. In 1948, the per sonal exemption of $600 equalled 42
percent of average personal per capita income, which was then
$1,4

34. Over the following 35 years, the personal ex emption lagged
far behind as income rose and inflation soared. While the 1986 tax
reform has raised the exemption to $2,000, this only partially
offset s the erosion in value since the 1940s. To have the same
value relative to in come it held in 1948, todays personal
exemption would have to be raised to around $6,300.

Young families are hard-pressed to meet the housing, health,
education and day care cos ts of raising children.The financial
difficulties experienced by families have led to a call for
government assistance in the form of new or 7larger social
programs, such as day care, additional health benefits, and help in
renting or purchasing a home. I f the tax burden on families were
reduced however, most families could meet their childrens needs
according to their own priorities and would not need new government
programs.

The current $2,000 personal exemption for children under age 18
should be returned to its post-World War Il value; this would be
$6,3

00. At this level the personal exemption would shield from taxes
about the same portion of in come as it did in 1948.This childrens
exemption would allow families to keep more of their income to pay
for the costs of raising children and the pressure for new federal
programs would be reduced 5) Provide Tax Credits to Households to
Cover Medical Expenses and Health Insurance Premiums Revenue
Reduction 40.9 billion (in 1991 dollars) when fully enacted.

The U.S. spends far more than any other country on health care
(over 11 percent of GNP) yet as many as 37 million Americans lack
health insurance while inflation plagues the health care system.
Prices have been rising rapidly because most Americans receive
health care benefits through their employers as tax-free income.
Employees tend to view these benefi ts as free and therefore have
little concern about the cost of health care services they use.
Similarly, health care providers know that their patient is not
paying directly for his or her care and so they, too, have little
incentive to curb costs.

The tax code, meantime, favors company-based health plans, while
in dividuals purchasing their own health insurance generally must
pay the full cost for protection, without tax relief.Thus workers
in small firms (which do not tend to provide health benefits or w
orkers in firms that do not cover de pendents, are discouraged by
the tax code from purchasing adequate health insurance.

Incentive to Insure. The problems of escalating health cost and
gaps in in surance coverage can be addressed by changing the tax
treat ment of medical care and health insurance premiums. Congress
gradually should end the tax the value of such plans as a taxable
pait of each employees wages. Then, to help employees carry this
extra cost, Congress should replace this tax benefit with a new
system of tax credits in the personal income tax code to offset the
cost of purchasing health insurance or health services
directly.This would give the uninsured a tax incentive to purchase
adequate insurance, while those currently with insurance would ha
ve a greater incentive to question the cost of their medical
services and insurance since they would be paying for it
directly.

Specifically, a 20 percent federal tax credit should be provided
for the pur chase of insurance coverage that meets basic requir
ements. In addition, a free fringe benefit status of company-based
health plans, thereafter counting 8 credit should be available for
out-of-pocket medical expenses. This percent age credit would
increase as total medical expenses rise as a percentage of f amily
income. By providing a larger credit for out-of-pocket expenses,
this reform would encourage families to pay directly for routine,
inexpensive ser vices and to reserve insurance for potentially
higher costs. This would en courage patients to shop ar ound for
routine services and to question costs more aggressively, thereby
helping to moderate charges.

The first stage of such a tax incentive for medid insurance is
contained in legislation passed last year (S. 5) by the Senate.The
measure, introduced by Senator Lloyd Bentsen, theTexas Democrat and
Chairman of the Senate Finance Committee, provides a tax credit for
insurance to cover children not covered by a company plan. Congress
should expand this credit, first to all de pendents and then to all
house holds, and offset the revenue loss with a gradual phase-out
of the tax-free status of company-provided health plans 6) Provide
Tax Incentives for the Purchase of Long-Term Care Insurance Revenue
Reduction 560 million per year.

Offsetting New Revenues: None.

Working Americans increasingly are concerned that long-term
nursing home costs could wipe out their savings retirement. Some in
Congress argue that the way to remove these fears is to create a
new federal entitlement pro gram for nursing home care, with the
federal government paying for these costs. But such an entitlement
would invite a surge in nursing home charges and the prospect of
Uncle Sam ultimately paying for care would remove all in centive
for todays workers to save for their own potential lo ng-term care
costs. Congress shouId recognize instead that the best way to
protect savings and other assets from the ravages of nursing home
costs is through insurance.

Americans use life insurance and homeowners insurance to protect
their as sets from catastrophes. They should be encouraged to
purchase long-term care insurance for the same purposes.

Currently very few Americans buy long-term care insurance. To
change this, the tax code should encourage working Americans to buy
long-term care insurance as a.routine way to protect their assets,
just as they routinely buy life insurance. In addition, the
government could give todays elderly tax assis tance to pay for
nursing home costs.This could be done in several ways. First
holders of Individual Retiremen t Accounts (IRAs 401(k) plans, and
similar tax-deferred savings plans could be allowed to withdraw
funds, tax free, to purchase long-term care insurance. Second,
Americans could use the tax credits detailed above for purchases of
long-term care insurance a n d nursing home costs. And third, there
should be no tax on benefits that insurance companies permit
policyholders to draw down from life insurance policies to pay for
nursing care during a terminal illness. The Prudential Insurance
Com pany of America, an d some other companies, already do offer
policyholders 9 tl U tl d 7 E fc n rc P H 0 H a tl tl rc e e d tl
tl tl n sl ZI 0 e e tl d a1 tl d h 12 he right to receive benefits
before death in certain circumstances. But it is inclear whether
these benefits ar e taxable under current 1aw.They should be reated
the same as life insurance benefits paid out when the policyholder
is leceased, which are not taxable Designate 100 Federal Enterprise
Zones to Spur Economic evelopment-in the Inner Citi Revenue
Reduction 6 60 million per year.

Offsetting New Revenues: The tax losses would be offset by
reductions in zderal outlays thanks to reduced rates of
unemployment, lower demand for relfare services, and a long-term
tax base broadened by increased employ lent and the cre ation of
new businesses.These savings could equal the direct evenue losses
of the program.

For decades the federal government has poured billions of
dollars into mericas inner cities with little impact on the
economic and social condition f these neighborhoods. Indeed,
ill-conceived federal projects and increased relfare dependency
seem to have hastened the decline of many cities.

In the late 197Os, however, several politicians and scholars
proposed a new pproach to combat urban blight, known as enterprise
zones. In contrast to le traditional strategy of pouring government
programs into the inne r cities ne enterprise zone proposal
involved reducing government intervention by educing federal
regulatory and tax burdens to provide incentives for conomic
development. The idea was to remove costly barriers to local
ntrepreneurs. The enterprise zone c oncept, pioneered in Britain,
was intro uced in the U.S. in 19

79. A majority of states now have some enterprise one
programs.There is evidence that the economic activity generated by
lese zones in many cases more than compensates for revenue lost
through le incentives. A 1988 report commissioned by the New Jersey
Department f Commerce, Energy and Economic Development, for
instance, finds that le state enterprise zone program has created
between 16,000 and 42,000 ew jobs in depressed urban areas and
raised between $1.90 and $5.20 in new tate tax revenue for every
dollar lost.

Dropping Barriers. The states, however, can only provide partial
nterprise are federal. Comprehensive federal enterprise zone
legislation ius is needed to complement local versions by reducing
the federal tax bur en.

A system of federal zones would mean federal tax and regulatory
relief in ddition to state incentives and thus remove more barriers
to inner city ven ires. A federal enterprise zone should remove
regulatory barriers to eve lopment, ease the transition of new
employees to work from welfare, and elp new businesses maintain
cash flow and attract investment. Federal legis ition also should
offer tax incentives, as proposed last year by Housing and
nterprize zone incentives. Man y of the tax burdens stifling inner
city 10 1 Urban Development Secretary Jack Kemp, and contained in
several congres sional bills, including measures introduced by
congressional leaders of both parties.These bills include such
incentives as an increase in the earned-in come tax credit to
low-income employees, a one-time capital gains tax exemp tion of
$lOO,OOO for the owner-operator of a small business, and capital
gains tax relief for investments in zone-based businesses I a 8)
Reduce the Capital Gains Ta x Revenue Reduction: None Offsetting
New Revenues 3.2 billion annual average.

The capital gains tax, which stood at 25 percent through most of
the 1950s and 196Os, was increased by the federal government
starting in 1968, until it reached a top rate of 34. 13 percent in
1978.The rates then were brought down over the next decade, falling
to 20 percent by 1982.Then the 1986 tax reform law brought the
rates back up to a maximum of 33 percent.

A tax on gains realized from the sale of such capital assets as
stoc ks, bonds and land discourages productive investments, and
slows economic growth by discouraging investment. Making matters
worse, the current capital gains tax constitutes a triple tax on
risk-taking investment.The first tax, the corporate tax, is paid b
y the enterprise on its profits. A second tax, on personal income
is paid when profits are distributed to shareholders in the
enterprise.The third tax, the capital gains tax, is paid on the
increased value of the stock when it is sold and part of this is a
tax on a mere paper gain because of infla tion.

Spurring Investment. The capital gains tax thus penalizes and
discourages productive new investments and movements of capital
from less productive to more productive uses. High capital gains
taxes also mean less money for the Treasury. Lower rates encourage
greater business activity and stock turn over and bring in more tax
revenue, as they did in 1979 and 1982 after cuts in the capital
gains tax. Harvard economist Lawrence B. Lindsey, now Associate
Director for Domestic Economic Policy at the White House, estimates
that the federal Treasury will lose between $27 billion and
$llO.billion dollars in revenue between 1987 and 1991 due to the
1986 increase in the capital gains tax from 20 percent to 33
percent in 1

86. Lindsey suggests that the rate that will pmduce maximum
federal revenue is around 15 percent.

Cutting the capital gains tax from the current 33 percent rate
to 15 percent would spur greater productive investment in the U.S
creating more jobs and ma king America more competitive. But it
would also generate more revenue for the federal government,
allowing greater tax cuts in other areas 11 9) Expand the Earned
Income Tax Credit Revenue Reduction 12 billion per year if combined
with an increase of Off setting New Revenues: None.

The goal of welfare policy should be to strengthen families and
encourage selfasufficiency Welfare programs thus should reinforce
the efforts of the poor to heip themselves rather than promoting
theprolonged dependency that is h armful to the recipient and
costly to the taxpayer. Because two-parent families provide a
healthier environment for raising children and are less prone to
poverty than single parent families, government policy should
protect and promote two-parent familie s wherever possible.

Tax Relief. Todays welfare system, however, generally promotes
family disintegration and dependency. An exception to this is the
Earned Income Tax Credit (EITC The EITC is a tax credit for
low-income workers. This tax relief is, in eff ect, an earnings
subsidy, obtained from the Treasury, to supple ment the take-home
wages of these workers. Moreover, the EITC is refun dable, meaning
that if the workers credits exceed his total tax liability he
receives the difference in a check from the government.The credit
is restricted to low-income employed parents with children.
Currently parents can receive a credit equal to 14 percent of their
earnings below $7,000 per year. As earnings rise above $7,000, the
credit gradually is phased out sistanc e to those in greatest need
low-income families with children.

Second, it is available to intact two-parent families as well as
single parent families, unlike many other welfare benefits.Third,
it is linked to work rather than to inactivity. And fourth, it
encourages work by providing higher benefits as work effort
increases.

Encouraging Self-Sufficiency. Expanding the EITC would increase
the in centive for low-income families to take a job and become
self sufficient. Cur rently the credit is not adjusted for family
size.The value of the credit should be increased, and the credit
should rise with the number of children so that families in the
greatest need get a large r credit. An additional credit also
should be awarded for dependent spouses to encourage the formation
and maintenance of intact two parent families up to $9,000 per year
for a dependent spouse and each school age child within the family,
up to a maximum o f three credits per family. Each pre school child
or dependent spouse caring for a pre-school child should receive a
credit equal to 12 percent of the familys earned income, up to a
maximum of three credits per family.

Under this system a two-parent family with two school age
children would receive a maximum credit of 24 percent of family
income, or $2,250 a year. A two-parent family with two preschool
children would receive a maximum credit of 36 percent of income, or
$3,240 per year the personal income t a x exemption for children to
$6,300 The EITC promotes family stability and self sufficiency.
First, it targets as A restructured EITC should provide a credit
equal to8 percent of easngs 12 ..I Escaping Poverty. This EITC
expansion would go a long way towar d eliminating poverty among
working families. When combined with other wel fare programs such
as food stamps, the expanded EITC would give a single working
mother with one or two children a family income above the poverty
level even if the mother earns onl y the minimum wage. A two-parent
family with two children would have an income above the poverty
level if the father worked a full year and the mother worked a
quarter of the year at the mini mumwage l I How much revenue
theTreasury would lose because of a n expanded EITC would depend
mainly on the rate at which the credits were phased out for
families with incomes above $90

00. Phasing out the EITC gradually is neces sary because losing
the credit means the family in effect faces a higher mar ginal tax
rate .The more rapid the phase out of the credit: the-higher
becomes the familys marginal tax rate. But if an expanded EITC were
to be combined with an increase to $6000 of the personal exemption
for children in the federal income tax, the proposed EITC credit s
could be phased down to zero for families with incomes above
$23,000 without imposing unduly high mar ginal tax rates 10)
Provide a Toddler Tax Credit Revenue Reduction 10 billion per
year.

Offsetting New Revenues: None.

The major problem facing America n families today is
overtaxation. In 1950 the median family of four paid just 2 percent
of its income to the federal government in taxes.Today that same
family pays 24 percent..of its income to the federal government.
This overtaxation places severe finan cial pressures on most
families, particularly on families with pre-school children. These
families either must forego the income of a second parent, so that
this parent can care for children in the home, or must pay high
costs for non-parental day care.

Th e current child care crisis is caused by this
excessive.government taxa tion. Government tax policy is pushing
millions of parents-of infant children into the labor force
contrary to their wishes; these parents are forced to place their
children in paid n on-parental care despite the fact that nearly
all parents agree that parental care is best for children.

Over 80 percent of the pre-school children using day care come
from two parent two-earner families. Nearly all mothers say that
they would prefer to remain at home with their children if they
could financially afford to do so.

Day Care Industry. The liberal response to these pressures on
the modern family is to tax families even more heavily and create a
system of government approved secular day care ce nters. Under this
plan, money would be taken from the pockets of families and given
to an industry funded by taxpayers to care for Americas children.
Polls show, however, that this is the childrearing 13 option
parents least prefer.The alternative is to e liminate the original
finan cial problem by reducing the tax burden on families with
young children.

Parents could use the added take-home pay to allow a parent to
stay home to care for pre-school children in the home. Or parents
could use the extra in com e to pay for day care that they, not the
government, select: care by rela tives, friends, neighbors, and
religious day care organizations, for example One.proposal,to
reduce.taxes on.families is known as the.toddler tax credit. Under
this plan, a tax cred i t equal to 10 percent of earned income
would be available to families with an annual income below Sl0,OOO
for each pre-school child (up to a maximum of two children per
family The credit also would be refundable, meaning that if the
available credit excee d ed the familys tax liability, that family
would receive the difference in a check from theTreasury. For
families with earned incomes between $lO,OOO and $30,000 the credit
would equal $l,OOO per child with a maximum limit of $2,OOO per
family.The credit w ould be phased down to zero for families with
incomes be tween $30,000 and M0,OOO 11) Expand Individual
Retirement Account Eligibility Revenue Reduction 4.5 billion per
year.

Offsetting New Revenues: Negligible.

By historical standards, Americans do not s ave enough. An
Individual Retirement Account is an excellent vehicle to encourage
savings. With an IRA, a taxpayer can obtain a tax deduction for
deposits made into such ac counts with both interest and profits on
such deposits accumulating tax free until they are drawn out upon
retirement. TheTax Reform Act of 1986 sharp ly restricted IRAs.

Before this IRAs were the only vehicle available to virtually
all workers in all circumstances. IRAs avoid all vesting problems,
since funds paid into an IRA immediate ly belong to the worker. The
accounts avoid all portability problems, since the IRA funds are
under the workers ownership and control wherever she or he goes.
Other pension plans usually are not fully available to a worker
unless she or he remains for sev eral years with a particular com
pany. Thus IRAs offer workers greater freedom and control than
Social Security or work pensions.

Expansion of IRA eligibility also would help raise Americas
savings rate by eliminating some of the discrimination in the tax
code against savings. The current tax system discourages savings by
effectively taxing it twice: first when it is accumulated through
earnings and again when the savings generate inter est. In effect,
the tax code makes it twice as costly to save as to co n sume.The
IRA deduction reduces the impact of this double taxation by
allowing Americans to defer taxes until retirement 14 Stimulating
Savings. The evidence suggests strongly that IRAs stimulate private
saving. A study by economists David Wise of Harvard a nd Steven
Venti of Dartmouth finds that 45 percent to 55 percent of IRA
contributions are new savings by individuals, 35 percent
constitutes money that would have been taxed had it not been
deposited in an IRA, and only 10 percent to 20 percent represents
money that would have been saved anyway and is merely shifted to an
IRA from some other form of savings Other countries provide various
tax incentives to stimulate saving. Japan for example, effectively
exempts interest income from taxes it also enjoys on e of the
highest personal savings in the world. Canada gives tax relief on
up to $l,OOO of investment income each year on Canadian
investments.

To encourage savings and to help Americans better plan for their
retire ment, IRA elig ibility should be restored to all
individuals, whether they are under private pension plans or not.
Further, the amount that can be deposited in an IRA for a
non-working spouse should be raised from $250 to 2,000. a
CONCLUSION The headlong rush in Washing t on to spend the
anticipated Peace Dividend is symptomatic of two instincts of
Congress: to use any excuse to create a new program; and to create
a spending program rather than to reduce taxes, since a new program
suggests that lawmakers are "doing somethi ng" to solve a problem.
New programs create a constituency of providers and service
recipients who are inclined to be grateful at election time.

But the range of problems now facing Congress, from concerns
about day care to worries about the cost of nursin g home care, are
examples of how returning money to Americans, through
carefully-crafted tax cuts, would be far better than taking dollars
from Americans and then giving them services to offset their lack
of personal resources.The prospect of a Peace Divi d end is like a
new jar of honey for the interest groups in Washington and
lawmakers who have an electoral interest in serving these
constituencies. It has given new vigor to a Congress that has been
constrained for years by the need to keep within Gramm-Ru
dman-Hollings guidelines for reducing the deficit.

Suddenly lawmakers can claim that billions of dollars are now
available for new -programs 3 Steven Venti and David Wise,
Tax-Deferred Accounts, Constrained Choice and Estimation of
Individual Saving Review of Economic Sntdes, August 1986, pp.
5794

01. See also StevenVenti and David Wise Have IRAs Increased US.
Saving Evidence From Consumer Expenditures Surveys National Bureau
of Economic Research Working Paper No. 2217, April 1987, and R.
Glenn Hubbard Do IRAs and Keoghs Increase Savings National Tar
Journal, March 1984, pp. 43-54 15 Dividend for Taxpayers. Americans
should be skeptical about the Peace Dividend. They should insist on
seeing real defense savings materialize before those savings are
committe d to new programs. And they should remind their
representatives in Congress that dividends normally are paid to
investors, not kept by the corporation.To the extent that there is
a Peace Dividend, it should be returned to taxpayers in ways that
address the problems faced by ordinary Americans, and not kept in
Washington to ea ~Qngressiona1:s~ending spree The Heritage
Foundation Domestic Policy Studies Staff Stuart M. Butler, Ph.D
editor I 16

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